Archive for June, 2015

Fama/French (2008): Momentum is “the center stage anomaly of recent years…an anomaly that is above suspicion…the premier market anomaly.”


This post will share a simple example of the power of momentum, and more specifically, the power of combining relative strength momentum with absolute momentum. Absolute momentum is often referred to as trend following or time-series momentum. We highly recommend those who want to go further in depth to pick up Gary Antonacci’s book, Dual Momentum Investing: An Innovative Strategy for Higher Returns with Lower Risk[1].


We will start by creating a benchmark global equity portfolio that is equally allocated to US large cap stocks, US small cap stocks, and International stocks[2]. The benchmark portfolio is rebalanced monthly. Our analysis period is 1972–2014 which includes three substantial bear markets (1973-1974, 2000-2002, and 2008-2009) along with one of the most prolific bull market runs in recent history from 1982–1999.

equal weight benchmark


equal weight benchmark stats

Since 1972 our benchmark portfolio has produced double digit annual returns with a Compound Annual Growth Rate (CAGR) of 10.85%, enough to grow $100 to $8,465.49[3]. Global equity markets have provided a substantial risk premium to investors who have been able to stay the course. But staying the course is the issue for most investors as even a globally diversified equity portfolio has experienced drawdowns approaching or exceeding 50% on multiple occasions. Drawdown measures the maximum amount of money lost from equity peak to valley. Taking our data back further, during the Great Depression US stocks experienced a drawdown exceeding 80%. Very few investors have the stomach lining to accept these kinds of drawdowns without abandoning a buy and hold investment plan. Painful losses in 2008 are still present in the minds of many evidenced by several studies showing how few investors have actually participated in the US stock market rally since 2009.


The conventional wisdom for dampening equity market risk is adding a permanent allocation of bonds to a portfolio. 60% stocks and 40% bonds is still the benchmark portfolio today. Unfortunately, permanently allocating a portion of a portfolio to bonds also produces lower returns, particularly in today’s historically low interest rate environment. This makes sense since conventional wisdom tells us that less risk equals less reward.


An alternative to buy and hold first discovered in the 1930’s is what many in finance call momentum. Momentum refers to the tendency for assets that have recently outperformed to continue outperforming in the near future. For example, if US stocks have outperformed International stocks over the past year this is likely to continue in the near future. In 1937 Cowles and Jones shared their findings that “taking one year as the unit of measurement for the period 1920 to 1935, the tendency is very pronounced for stocks which have exceeded the median in one year to exceed it also in the year following.” Hundreds of academic papers have confirmed the existence of momentum for decades, even centuries, across asset classes and around the world. Momentum is persistent and pervasive yet largely misunderstood and unused by investors of all size.


Instead of equally allocating to a permanent allocation of US large cap stocks, US small cap stocks, and International stocks, our first example of momentum investing will invest in whichever of the three had the highest return over the prior twelve months. Researchers often refer to this method as relative strength momentum.

12 month relative momentum


12 month relative momentum stats

The findings of Cowles and Jones from 1920-1935 have continued to persist nearly eighty years after their discovery. Our relative strength momentum model increased returns by almost 4% per year. Now, instead of a $100 investment growing to $8,465.49 from 1972-2014 it grows to $34,671.38 over the same period. Many investors are unaware of how seemingly modest improvements in annualized return can make a meaningful difference over a long period of time to ending wealth. But we still have to deal with the pain factor (drawdowns), and our data shows that relative momentum does nothing to reduce bear market risk as maximum drawdown was essentially unchanged. We already know very few investors can take the punishment of a 55% drawdown and are normally advised to reduce equity market exposure in exchange for lower returning assets such as cash and bonds. Studies have shown how investors feel the pain of loss twice as strongly as the pleasure from an equivalent gain. Jason Zweig’s research found that financial losses are processed in the same part of the brain that responds to mortal danger. This is something we can’t ignore because the right investment plan for a prudent investor is the one they can stick with for the long term even if that results in a lower expected return. Investing heavily in equities and crossing your fingers that 50%+ bear market drawdowns won’t happen again is a recipe for financial disaster. The reason stocks tend to produce high long term rewards is because of their inherent risk. Bear markets will occur again, to think otherwise is ignoring history.

More recently, researchers have been studying the benefits of combining relative momentum with what many practitioners call absolute momentum, or time-series momentum. Many commodity trading advisors (CTA’s) have been practicing absolute momentum in the form of trend following for decades with significant success. Absolute momentum acts as a risk management tool where you compare returns of an asset to itself instead of relative to other risk assets. For example, if US Stocks have a negative return over the prior twelve months there is also a strong likelihood of negative returns continuing in the near future. Buying tends to attract more buying just as selling attracts more selling. A sensible rules based approach is to then seek safety in the form of cash or short term bonds until stock returns again become positive over the prior year.

So we will now combine relative momentum with absolute momentum where each month we chose among the top three of our equity markets, and if none have positive excess returns (asset return minus the risk free return of treasury bills) over the past year we will allocate to bonds instead. No predictions, opinions, or forecasts necessary. The fact that our model has no discretionary inputs is an important and refreshing distinction from traditional active portfolio management. Philip Tetlock spent two decades quantifying “expert” predictions finding that the vast majority performed worse than random chance when it came to predicting the likelihood of an outcome.

dual momentum


dual momentum stats

Our dual momentum approach of combining relative and absolute momentum has outperformed our equally allocated global stock market benchmark by almost 7% annually since 1972. This now grows a $100 investment to $108,959.95 instead of $8,465.49. But perhaps more important to most investors is that dual momentum reduced the maximum drawdown by more than half (from 52.42% to 22.89%) due to the effect of our absolute momentum rule largely sidestepping the three major equity bear markets of 1973-1974, 2000-2002, and 2008-2009. Dual momentum has shown the ability to be used as a simple rules-based method to produce higher returns with less risk than buy and hold. Those who choose to ignore the power of dual momentum also chose to ignore significant empirical evidence, and may be doing so at their own financial peril.

So what does this information mean to you? We wrote this paper to provide a simple example of one of our favorite methods we use to manage client assets.  Most of our clients aren’t interested in every detail, only enough detail to increase investor confidence.  As an independent investment advisory firm we have the freedom and flexibility to implement compelling research for our clients. Advisors captive to sales-based production requirements are often incentivized to provide proprietary products instead of conducting robust investment research that can benefit both the client and the advisor over the long term.

This simple dual momentum method could also be a fantastic strategy for a portion of one’s 401k or other employer retirement accounts. On average, less than 2 trades occur per year so total time commitment may be around 5-10 minutes per month with most months requiring no action. We suggest you consider the difference in wealth from our above example to decide if this may be worth the effort. Many will spend more time planning their next vacation than they ever will with regard to maximizing the efficiency of their life savings. Blindly trusting an advisor without a fiduciary duty to act in your best interest is very common. More complex methodologies could certainly be pursued, but we believe simple beats complex over the long term. Leonardo da Vinci once said “Simplicity is the ultimate sophistication.”

Feel free to contact us if you’d like to discuss your specific situation further. We welcome every opportunity to discuss how we could add value to your financial life.

[1] Gary Antonacci is not affiliated with Lorintine Capital. Lorintine Capital does not receive any compensation for mentioning his book nor is it an endorsement. We provide his book as a third-party reference for those interested in learning more about momentum and the concepts presented in this paper.

[2] Historical data represents index data. You cannot invest directly in an index. Indexes do not include fees, expenses, or transaction costs. All examples are hypothetical. Past performance does not guarantee future results.

[3] CAGR – Compound Annual Growth Rate. TBill CAGR – Treasury bill Compound Annual Growth Rate, often referred to as the risk free rate of return. Stdev – Annualized volatility of monthly returns. Sharpe – Sharpe Ratio, a commonly used ratio for measuring risk adjusted returns. MaxDD – Maximum Drawdown, which measures the maximum peak to valley decline experienced on a month ending basis. $100 becomes – What an initial $100 investment would have grown to from 1972-2014. Inflation CAGR – Inflation Compound Annual Growth Rate.


SITREP: n. a report on the current situation; a military abbreviation; from “situation report”.


The very big picture:

In the “decades” timeframe, the question of whether we are in a continuing Secular Bear Market that began in 2000 or in a new Secular Bull Market has been the subject of hot debate among economists and market watchers since 2013, when the Dow and S&P 500 exceeded their 2000 and 2007 highs.  The Bear proponents point out that the long-term PE ratio (called “CAPE”, for Cyclically-Adjusted Price to Earnings ratio), which has done a historically great job of marking tops and bottoms of Secular Bulls and Secular Bears, did not get down to the single-digit range that has marked the end of Bear Markets for a hundred years, but the Bull proponents say that significantly higher new highs are de-facto evidence of a Secular Bull, regardless of the CAPE.  Further confusing the question, the CAPE now has risen to levels that have marked the end of Bull Markets except for times of full-blown market manias.  See Fig. 1 for the 100-year view of Secular Bulls and Bears.

Fig 1

Fig. 1

Even if we are in a new Secular Bull Market, market history says future returns are likely to be modest at best.   The CAPE is at 27.2, barely changed from the prior month’s 27.5, and approximately at the level reached at the pre-crash high in October, 2007.  In fact, since 1881, the average annual returns for all ten year periods that began with a CAPE at this level have been just 3%/yr (see Fig. 2).

Fig 2

Fig. 2

This further means that above-average returns will be much more likely to come from the active management of portfolios than from passive buy-and-hold.  Although a mania could come along and cause the CAPE to shoot upward from current levels (such as happened in the late 1920’s and the late 1990’s), in the absence of such a mania, buy-and-hold investors will likely have a long wait until the arrival of returns more typical of a rip-snorting Secular Bull Market.

In the big picture:

The “big picture” is the months-to-years timeframe – the timeframe in which Cyclical Bulls and Bears operate.  The US Bull-Bear Indicator (see Fig. 3) is at 55.6, up from the prior month’s 55.3, and continues in Cyclical Bull territory.  The current Cyclical Bull has taken the US and some of Europe to new all-time highs, but many of the world’s markets have yet to top 2007’s levels – particularly in the Emerging Markets area.

Fig 3

Fig. 3

In the intermediate picture:

The intermediate (weeks to months) indicator (see Fig. 4) is Negative and ended the month at 27. Separately, the quarter-by-quarter indicator – based on domestic and international stock trend status at the start of each quarter – gave a positive indication on the first day of January for the prospects for the first quarter of 2015.

 Fig 4
Fig. 4

Timeframe summary:

In the Secular (years to decades) timeframe (Figs. 1 & 2), whether we are in a new Secular Bull or still in the Secular Bear, the long-term valuation of the market is simply too high to sustain rip-roaring multi-year returns.  In the Cyclical (months to years) timeframe (Fig. 3), all major equity markets are in Cyclical Bull territory.  In the Intermediate (weeks to months) timeframe (Fig. 4), US equity markets are rated as Negative.  The quarter-by-quarter indicator gave a positive signal for the 2nd quarter:  both US equities and International equities were in uptrends at the start of Q2 2015, and either one being in an uptrend is sufficient to signal a higher likelihood of an up quarter than a down quarter.

In the markets:

The major US indexes ended lower for the week as the Dow gave up 221 points, or -1.21%, to barely maintain the 18,000 level at 18010.  The LargeCap S&P 500 lost -0.88%, to close at 2107.  The tech heavy Nasdaq declined ‑0.38%, holding above the 5,000 mark at 5070.  The SmallCap Russell 2000 lost -0.45%, and the MidCap 400 gave up ‑1.10%.  Canada’s TSX lost for the fourth week in five, shedding -1.23%.

Emerging International Markets lost -3.79% for the week, while Developed International was down -1.97%.  Most European indices gave up -2% to -4%, and Brazil led the parade of losers at -5.73%.  Japan’s Nikkei was an exception, gaining +1.47%.

In commodities, the price for a barrel of crude flattened out holding steady at $60.23, up +0.40%.  Gold declined ‑1.24%, to close at $1190.50 an ounce.  Silver, almost always more volatile, gave up -2.31% to close at $16.71 an ounce.

Despite the downbeat ending of the month, May was positive for US markets.  The Dow was the least positive, at +0.95% for May, and the Nasdaq composite was the most positive, at +2.6%.  The S&P 500 rose +1.05%, the SmallCap Russell 2000 gained +2.16% and the MidCap 400 advanced +1.63%.  Canada’s TSX was not so lucky, shedding -1.38% for May.  The rest of the world was a mixed picture.  Developed International went up a small +0.20%, but the Emerging Markets group plunged ‑4.10% in May.  The swings were most pronounced in China and Brazil (many have observed that Brazil seems to be a delayed mirror of China these days, since such a large % of Brazil’s GDP is now in trade with China).

In economic news, the Commerce Department reported that first quarter GDP contracted ‑0.7%.  The revised figure was much worse than the government’s initial estimate of a +0.2% growth rate.  It should be noted that the first quarter of 2014 was also a GDP contraction.  Consumer spending, which accounts for about 70% of economic activity, grew only +1.8%.  Business investment declined -2.8%, which was the biggest decline since 2009.  One of the biggest hits to business investment came from huge cutbacks in drilling activities for energy companies.  The Chicago Purchasing Managers Index (PMI) for manufacturing fell -6 points to 46.2, near a 6-year low of 45.8.  Expectations were for an uptick to 53.1.  Above 50 is expansion, below 50 is contraction in the PMI.

Initial jobless claims increased a modest 7,000 to a still low 282,000.  Initial claims have remained near 15-year lows for several weeks now.  Continuing claims gained 11,000 to 2.222 million, the lowest since November, 2000.

Orders for durable goods declined -0.5% in April, not quite as bad as consensus estimates of a -0.6% decline.  Orders excluding transportation increased +0.5%, beating expectations by one tick.  On a positive note, core capital goods orders, which often serve as a proxy for business investment intentions, gained +1% – hopeful news for second quarter GDP.

The Services PMI declined -1 point to 56.4 in May, but remained in solid expansion territory.  Job creation accelerated to its fastest pace in a year, and the year-ahead optimism index also rose to the highest since late last year.  The Conference Board reported that consumer confidence improved in May to 95.4, beating expectations of 95.1.  The component that gauges opinions of “the present situation” gained+ 3 points to 108.1.

New-home sales rose 6.8% to an annual rate of 517,000 in April, expectations were for 509,000.  Sales have remained over 500,000 for four of the first five months of 2015 – much hotter than in 2014.  The S&P/Case-Shiller home price index was also stronger in April, with a +1% gain for the month and +5% higher year over year.  San Francisco and Denver held the top spots for price gains.  Nationally, prices are still about 15% lower than the 2006 peak.

Canadian GDP contracted -0.6% in Q1 vs the previous quarter, missing expectations of a +0.2% gain.  It was the first decline in almost 4 years and was due to the steep drop in oil and gas activity.  Industrial product prices fell ‑0.9% in April in Canada, much steeper than expected, and are now down ‑2.4% vs. a year ago.  The price index for raw materials increased +3.8% vs. expectations of a ‑1.6% decline, but the index is still -20.9% lower than last year’s levels.

Getting frugal German consumers to loosen their purse strings has been a very difficult task over the last few years while Europe flirted with several recessions and the Greek government openly disparaged Germany and Germans.  However, there are recent signs that German consumers may be coming around.  Consumer sentiment in Germany was stronger than expected in April, according to market-research firm GfK, rising to the highest reading since 2001.  A sub-gauge of “buying willingness” improved to its highest since 2006.

A top IMF official stated that the Chinese yuan is no longer undervalued.  China has been pressing to have the currency considered part of the Fund’s special reserve assets—having the yuan considered fairly valued is a major step toward that goal.

Advisor and author Ben Carlson published an article on Yahoo! Finance this week titled “To Win in the Stock Market You Have to be Willing to Lose”.  He analyzed the S&P 500’s worst drawdowns (measured as the decline from market peak to subsequent trough) from 1950-2014 and related the findings to 2 different types of investors—those who obsess over the next 5-10% correction and those that have become so complacent they don’t think about it at all.  He points out that both attitudes can be hazardous to one’s financial health because both types are set up to over-react to the market’s historically-typical movements.   More than half of all years have experienced a drawdown of -10% or more, and a sixth of all years suffered a -20% or greater loss.  There were only 4 years – 1954, 1958, 1964, and 1995 – in which stocks didn’t have at least a -5% correction at some point during the year.

in the markets

(sources: Reuters, Barron’s, Wall St Journal,,,,,,, Eurostat, Statistics Canada, Yahoo! Finance,,, BBC,,,; Figs 3-5 source W E Sherman & Co, LLC)


The US has led the worldwide recovery, and continues to be among the strongest of global markets.  However, the over-arching Secular Bear Market may remain in place globally even as new highs are reached in the US.

Because the world may still be in a Secular Bear, we have no expectations of runs of multiple double-digit consecutive years, and we expect poor market conditions to be a frequent occurrence.  Nonetheless, we remain completely open to any eventuality that the market brings, and our strategies, tactics and tools will help us to successfully navigate whatever happens.

Fig 5

Fig. 5